BOC More Dovish Than Expected, Warned Of Sluggish Growth

The BOC left the policy rate unchanged at 1% in July and maintained a neutral tone on the monetary policy outlook. Despite the recent pickup in inflation, the central bank attributed it to temporary factors such as ‘higher energy prices, exchange rate pass-through and other sector specific shocks’. That said, they removed the reference that there remained ‘downside risks’ on inflation. Policymakers were concerned about the economic growth, seeing ‘substantial slack’ in the economy and expecting a delay in closing of the output gap than previously anticipated. At the Monetary Policy Review (MPR) released, the BOC revised higher inflation outlook for this year but lower for 2015. GDP growth was revised lower for this year.

Headline CPI in Canada rose +2.3% y/y in May, up from +2% in April. Excluding energy, the reading rose +1.7% y/y in May, accelerating from +1.4% in April. The BOC’s index of core CPI also rose to +1.7% from +1.4% in April. Regarding such development, the central bank acknowledged that inflation had exceeded its expectations over the past few months but judged that the improvement was due to the ‘the temporary effects of higher energy prices, exchange rate pass-through and other sector specific shocks, rather than to any change in the domestic economic fundamentals’. As shown in the latest MPR, the BOC raised its headline inflation forecast to 1.9% for 2014, up from +1.7% estimated previously. Core inflation was also revised higher to +1.6% from +1.4% previously. However, forecast for headline CPI for 2015 was revised down to +1.7% from +2.0% while that for core inflation stayed unchanged at +1.7%.

Policymakers were more concerned about the economic growth outlook, especially after ‘serial disappointment’ in the global economy in recent years. As an exports economy with the closest trading partner the US, the BOC warned of the ‘less underlying momentum in the US economy’. The central bank lowered its forecast of global economic growth to 2.9% (from 3.3%) for this year, mainly in response to the weak growth in 1Q14 in the US, to 3.6% (from +3.7%) for 2015. Domestically, growth in Canada is revised lower to +2.2% from +2.3% for 2014 and to +2.4% from 2.5% for 2015. Growth for 2016 is revised higher to +2.3% from +2.2%. The BOC stressed that that ‘for the inflation target to be achieved on sustained basis in 2016, the economy must reach and remain at full capacity’.

The statement more dovish than expected as the BOC were not too optimistic about the growth outlook and viewed recent rise in inflation as temporary. Going forward, the central bank would continue to focus on measures of excess capacity, such as wage inflation. As a close trading partner with the US, BOC would also be closely monitoring the FOMC’s actions.

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